Does Decentralization Lessen or Worsen Poverty? Evidence from

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1 Does Decentralization Lessen or Worsen Poverty? Evidence from Post- Big Bang Indonesia* SUDARNO SUMARTO Senior fellow, SMERU Research Institute Policy adviser, National Team for the Acceleration of Poverty Reduction (TNP2K), Office of the Vice President of Indonesia Stanford University, 12 December 2013 *Based on Sumarto S., Vothknecht M. and Wijaya L. (2013): Explaining Regional Heterogeneity of Poverty: Evidence from Decentralized Indonesia

2 Decentraliza+on and poverty reduc+on: an overview The link between decentraliza1on and poverty reduc1on is not straigh9orward and is largely influenced by country specifici1es, as well as process design OECD (2004) review of decentraliza1on experiences in 19 countries finds improvements in poverty reduc1on in only one third of cases. Countries that were more successful in reducing poverty following decentraliza1on: Ø Lower middle income countries, with literacy rates above 80%, and rela+vely open poli+cal process Condi1ons required for decentraliza1on to have a posi1ve impact on poverty: Ø Adequate commitment from the central government, (financial and technical) capacity of the LGs, local- level checks and balances SMERU Research Institute

3 Outline 1. Big Bang decentraliza1on in Indonesia 2. Indonesia s recent progress in reducing poverty 3. Determinants of poverty at the local level a) Income genera1ng capacity b) Delivery of public services and other governance aspects of decentraliza1on c) The establishment of TKPKD 4. Summary of Empirical Findings 5. Conclusion & Follow- up Research

4 Indonesia has seen considerable change over the past 20 years 1 Sharp declines in poverty Recovery, stability, resource boom Worst affected by Asian Financial Crisis Big Bang Decentraliza+on EXPECTATIONS Fairer resource alloca+on Greater representa+on and equity More appropriate decision making Faster poverty reduc+on Development dynamics are a long- term phenomenon, involving decades rather than years

5 Indonesia s Big Bang Decentralization (1) Despite its size and heterogeneity, Indonesia adopted a Big Bang decentraliza1on approach in 1998, moving the country from one of the most centralized systems in the world to one of the most decentralized. Fiscal, administra1ve, and poli1cal decentraliza1on are implemented at the same 1me, based on the 1999 and 2000 laws on regional autonomy and fiscal decentraliza1on. Indonesia s regions are granted broad autonomy in all but a few tasks (including defense, security, jus1ce, foreign affairs, fiscal and monetary affairs, as well as religious affairs)

6 Indonesia s Big Bang Decentraliza+on (2) From 2001, the responsibility for most public services is decentralized to the local level: Doubling of regional share in government spending, and subna1onal spending makes up about half of consolidated government total spending, net of interest payments and subsidies. 2/3 of the central civil service was reassigned to regions, and More than 16,000 public service facili1es were handed over to the regions Central and subna+onal spending as a share of consolidated government total expenditures Central (minus transfers, subsidies & int. payments) Sub-national `98 `99 `00 `01 `02 `03 `04 `05 `06 `07 `08 `09 `10 `11

7 Decentraliza+on and its hasty prepara+on have lep much unfinished business in Indonesia Lacks key ins1tu1onal requirements for an effec1ve management of the process, e.g.: Ø Absence of performance measures and an effec1ve framework of constraints Ø Unclear division of responsibili1es between the different levels of government weak local accountability Ø Insufficient human and ins1tu1onal capacity of local governments Ø Inappropriate incen1ves given by the structure of decentralized public finance (e.g. encourage pemekaran )

8 8 Nevertheless, decentralized Indonesia has made progress in addressing absolute poverty but with new challanges 2 41 Gini Ratio(%) Poverty reduction was driven by sustained economic growth and job creation. Poverty Rate (%) But the pace of poverty reduction is slowing and inequality is rising. Unemployment Rate (%) Real Economic Growth (% p.a) Per Capita Income (US$)

9 ...and Districts are converging (%) Poverty Head Count, 2005 (%) Regions with ini1al higher levels of poverty tend to experience a larger decrease in poverty (- > convergence) Confirma1on of an overall convergence in poverty levels at district level SMERU Research Institute

10 However, progress has been uneven and a substan+al heterogeneity remains 2nd Highest Decrease of Poverty Headcount MUSI BANYUASIN SOUTH SUMATRA (- 19.1) Change in Poverty Headcount, st Highest Decrease of Poverty Headcount SORONG CITY WEST PAPUA (- 23.4) 2nd Highest Increase of Poverty Headcount MANOKWARI WEST PAPUA (16.0) Legend Data Unavailable 1st Highest Increase of Poverty Headcount TELUK BINTUNI WEST PAPUA (21.6) Substan1al varia1on in poverty levels and trends both across and within regions So the objec+ve of the paper: inves1gate the determinants of the observed differences in Ipnstitute overty SMERU Research

11 Exis+ng evidence from Indonesia Skoufias & Olivier (2013) find that differences in the returns to household mobile characteris1cs are the primary explana1on of the welfare differences across regions. Hill (2002) finds that disparity in poverty levels is increasing instead of converging. This is a cause of concern because: Ø an increase in inequality across districts can bring social and poli+cal unrest, Ø and thereby reduce the impact of the Government of Indonesia s overall poverty reduc+on strategy.

12 Determinants of local poverty (1) 3 Income genera+on capacity at the local level Ø the main source of income is s+ll transfers from the central government in 2011, on average 91% of district revenue comes from the central government In addi1on close to 64% of direct spending within districts also comes from the central government Ø local governments are able to generate their own income evidence of harm done to the investment climate with complex and problema1c regula1ons that onen overlap with na1onal regula1ons the presence of natural resources is a key determinant of the amount locali1es can generate SMERU Research Institute

13 Determinants of local poverty (2) Performance in delivering public services Ø fiscal abili+es in the educa1on sector, the district of Badung (Bali) spent nearly Rp. 250 million in addi1on to funds provided by the central government in 2008, while the district of North Mamuju (West Sulawesi) allocated less than Rp. 40 million for educa1on in the same year. In terms of spending per capita, Badung spent 50% more than Mamuju. Ø technical capacity about two- thirds of the villages in the country, par1cularly in eastern Indonesia, s1ll have no access to telecommunica1on networks local government spending on wage expenditure rather than services. Lack of accountability at local levels SMERU Research Institute

14 Determinants of local poverty (3) Governance aspects of decentraliza+on Ø Generally, decentraliza1on has not led to a notable increase in violence Ø However, The Crisis Group (2005) links administra1ve decentraliza1on to conflict due to redistric1ng Ø By dividing a district into two or more en11es (Pemekaran), locali1es may receive increased block grant amounts from the central government Ø Yet, this process may causes social tension and violence as occurred in for example Mamasa, Papua and Musi Rawas

15 Conflict in Mamasa, Musi Rawas & Papua related to Pemekaran Mamasa: Musi : Papua:

16 Determinants of local poverty (4) District ins+tu+onal capacity for poverty reduc+on Ø TKPKD: overseeing and coordina+ng the design and implementa+on of local poverty reduc+on strategies. Ø Main responsibili+es of TKPKDs: management and development of local poverty indicators, development of a poverty informa1on system, establishment of an early warning system on poverty issues.

17 Building the capacity of TKPKDs for poverty reduc+on SMERU Research Institute

18 Establishment of TKPKD at District Level Less than 35% (175) of districts established TKPKD by end of 2005 As of 2010 about 20% of districts had not established a TKPKD; of which nearly half of are located in the eastern part of the country. The degree by which exis1ng TKPKD are ins1tu1onalized varies widely across districts. SMERU Research Institute

19 Link between TKPKD and Poverty Reduc+on Changes in Poverty by TKPKD Status Not yet established Present 1-2 years Present 3 or more years Change in Headcount Change in Poverty Gap Districts that have established TKPKDs reduced poverty more than those that have not. The empirical analysis allows disentangling the effect of TKPKD from other socio- economic determinants of poverty SMERU Research Institute

20 Empirical Analysis District- level panel dataset with annual observa1ons for the period 2005 to 2010 Control variables include Ø Economic condi+ons (GDP, structure of the economy) Ø Socio- demographic condi+ons (educa+on, inequality, conflict history, urbaniza+on) Ø Ins+tu+onal condi+ons (educa+on of leaders, fiscal revenues, TKPKD establishment) Econometric approach: panel regressions with fixed and random effects see Appendix

21 Summary of Empirical Findings 4 Poverty appears to have decreased more in districts with: Ø established a local office for the coordina+on of poverty reduc+on ini+a+ves (TKPKD) Ø a higher share of fiscal revenues but less successful when fiscal revenue represent 50% (and above) of RGDP Ø a larger share of local leaders with secondary educa+on Ø a higher average educa+onal aaainment Ø a higher share of urban popula+on.

22 Conclusion & Follow- up Research 5 Findings consistent with previous studies Regional output, poverty reduc1on and income distribu1on are found strongly interrelated A successful development strategy requires effec1ve, region- specific combina1ons of growth and sound social policies Ø Rapid and sustainable regional economic output is viewed as the primary vehicle for poverty reduc+on. Ø Sufficient fiscal and ins+tu+onal capacity as a pre- condi+on to efficient public services to support poverty reduc+on Follow- up Research: Delving more into the TKPKD black box (what make them work and not work) and addressing the endogeneity issue Further inves+gate the role of local leaders

23 Appendix

24 Econometric Approach Panel regressions on poverty (i) headcount and (ii) gap Use of random (RE) and fixed effects (FE) models to exploit the longitudinal dimension of the data Allows controlling for regional / local characteris1cs that are constant over 1me (cultural astudes, geographic and clima1c condi1ons, etc.) Given the complex interrela1ons between poverty and the other socio- economic condi1ons, no causality is claimed Goal: Iden1fica1on of the factors most related to local poverty (reduc1on) in a decentralized Indonesia

25 Regression Results Control variables Poverty Headcount Poverty Gap RE FE RE FE GDP per capita (real, w/o mining) Fiscal revenues (as share of GDP) *** *** *** *** Education (Average years of schooling) *** *** *** *** Education Village heads (no sec. education) 7.77 *** 6.56 ** Urban population (share total population) * TKPKD: active for 1-2 years *** *** ** *** TKPKD: active for more than 3 years *** *** *** *** Inequality: Gini Coefficient *** 0.06 *** Recent history of large scale violence 4.44 *** 1.05 *** Observations Pseudo- R Included, but not reported: GDP share of agriculture / mining; regional dummies

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